For banks and other financial institutions, risk measurement plays a central role. Risk levels must conform to the capital adequacy rule. An error in the computed risk level may thus affect a bank's investment strategy. The state of the art is measuring risk by analyzing daily data: using one market price per working day and per financial instrument. In this description, the stochastic error of such a risk measure is demonstrated in a new way, concluding that using only daily data is insufficient.
The challenge for statisticians is to analyze the limitations of risk measures based on daily data and to develop better methods based on high-frequency data. This description meets this challenge by introducing the time series operator method, applying it to risk measurement and showing its superiority when compared to a traditional method based on daily data.
Intra-day, high frequency data is available from many financial markets nowadays. Many time series can be obtained at tick-by-tick frequency, including every quote or transaction price of the market. These time series are inhomogeneous because market ticks arrive at random times. Irregularly spaced series are called inhomogeneous, regularly spaced series are homogeneous. An example of a homogeneous time series is a series of daily data, where the data points are separated by one day (on a business time scale which omits the weekends and holidays).
Inhomogeneous time series by themselves are conceptually simple; the difficulty lies in efficiently extracting and computing information from them. In most standard books on time series analysis, the field of time series is restricted to homogeneous time series already in the introduction (see, e.g., Granger C. W. J. and Newbold P., 1977, Forecasting economic time series, Academic Press, London; Priestley M. B., 1989, Non-linear and non-stationary time series analysis, Academic Press, London; Hamilton J. D., 1994, Time Series Analysis, Princeton University Press, Princeton, N.J.) (hereinafter, respectively, Granger and Newbold, 1977; Priestley, 1989; Hamilton, 1994). This restriction induces numerous simplifications, both conceptually and computationally, and was almost inevitable before cheap computers and high-frequency time series were available.